Phoenix suddenly is back near the top of the list of the nation's healthiest apartment markets. And after decades of being one of the most cyclical performers in the country, the area now seems poised for a sustained run as a preferred market.
What's different now? First, economists foresee the sort of explosive job growth that only Atlanta and Dallas have posted consistently over the past couple of decades. Second, with a big run-up in home prices during the past year, purchases now are moving out of reach for a sizable segment of the populace–quite a change for a market where most households traditionally made only a brief stop in apartments before moving on to buy homes. And third, development challenges are mounting, suggesting a slowdown in future deliveries.
Today's investments clearly look like smart plays for the next two or three years, and it appears that these assets should produce attractive revenue returns throughout the longer term, too.
Desert Bloom
The Phoenix apartment market made one of the biggest comebacks seen anywhere in the nation during 2005. By the end of the year, occupancy reached 95.5 percent, more than 2 percentage points ahead of its late-2004 performance and up more than 5 points since bottoming in mid-2003. Though operators were hesitant to push rents early in 2005, they got more aggressive as the year drew to a close. Annual rent growth ended up at a whopping 7.3 percent, measuring change on a same-store basis.
Owners and managers had plenty of room to raise rents because for-sale product prices shot through the roof. While Phoenix's median single-family home price–around $268,000, according to the National Association of Realtors–is not especially high by U.S. standards, the 55 percent price jump seen here over the past year was the biggest increase across the country. Nobody expects this phenomenal growth in home prices to be sustained, but just the past year's price jump has been enough to make for-sale product too expensive for thousands of the metro's renter households.
A fast-growing economy provided additional support for housing of all sorts in Phoenix in 2005. The metro produced roughly 70,000 new jobs–a 4 percent employment growth rate, and a total second only to that of the Washington, D.C., area. Economists remain very optimistic about Phoenix's prospects. Forecasts call for the metro to duplicate its 2005 success in 2006, in contrast to the slight slowdown in new jobs expected in many other markets, and it wouldn't be surprising to see Phoenix take over the top spot nationally in total job creation this year. Moreover, most economists anticipate that Phoenix will be far and away the country's job production leader in the next decade.
Fairly modest completion numbers also are playing a key role in Phoenix's recently improved occupancy and rent growth pace, with new supply limited to just under 5,200 units in 2005. This was the metro's third consecutive year of restrained deliveries, after new supply had averaged more than 8,300 units annually from 1999 to 2002. Furthermore, existing apartment inventory actually shrank in 2005, as condo converters suddenly discovered the market in a big way. Rental communities totaling about 10,600 units were taken off line for condo conversion. About half of these conversions occurred in the upscale city of Scottsdale, in the metro's northeast corner, where the existing base of rental product was reduced more than 15 percent in 2005.
Apartment building in Phoenix now is trending upward but so far hasn't hit its former highs. Just over 6,000 units were under construction at the start of 2006, and future product availability will be the key factor in shaping long-term prospects in Phoenix's apartment market. Opinions on the likely volume vary widely. With American Indian reservations blocking sprawl on several sides, the limited land currently zoned for multifamily building suggests that apartment deliveries won't reach the volumes of past economic booms. On the other hand, development density in most neighborhoods is incredibly low by national standards. Developers experienced in markets with high barriers to entry look at Phoenix and see an array of parking lots and other underused real estate that could accommodate tens of thousands of additional housing units.
Even if total building capacity is far beyond the volumes called for by the most conservative estimates, this market will require creativity to get a new project under way. That alone should help space out the delivery timing of future completions.
Today's list of active developers in Phoenix suddenly looks much like it did during the construction boom that started the decade. Fairfield Properties, which operates out of San Diego and Dallas, delivered more than 4,500 units in this market between 2000 and 2002. After a three-year break in completions, Fairfield is building four projects that total about 1,100 units. Likewise, Atlanta-based Trammell Crow Residential, very busy during the metro's last peak in construction, has returned to the market after a three-year hiatus. The firm started four communities totaling just over 1,000 units during 2005's last half, and an immediate construction start date is slated for at least one more project. At the same time, three notable local players remain active: Mark-Taylor Development continues to crank out one or two top-of-the-market properties every year; Gray Development has two mid-tier communities in process; and Ruiz Development, the metro's most prolific builder recently, concentrates on affordable product.
Go West
Development activity in metro Phoenix traditionally has been very eastside-heavy, occurring along the corridor that stretches from Scottsdale at the northern end to the tech-dominated job centers in Chandler and Gilbert at the southern end. But with only a handful of sites zoned for multifamily construction in this eastern part of the metro, the development focus has moved. One pocket of activity extends along the Interstate 17 corridor that leads northward from the heart of the city. Development in this area previously focused on golf resorts and high-end single-family home subdivisions. Even more significant, the far western parts of the metro–cities like Glendale, Peoria, and Goodyear–have taken on a huge role in the total development picture.
Glendale is a particularly noteworthy hub of both commercial and residential building. A $335 million stadium for the Arizona Cardinals football team is under construction. Also, Glendale Arena, a new multipurpose facility that is home to the Phoenix Coyotes hockey team and the Arizona Sting lacrosse team, is in place. The arena is part of a mixed-use development called Westgate City Center, where 500,000 square feet of office, retail, and entertainment space began to come online in late 2005. Trammell Crow Residential will build the development's residential component, with construction scheduled to start on the 251-unit Alexan Westgate by the middle of 2006.
Turning to Phoenix's urban core, residential development so far has been fairly limited–far below the volumes seen in Sun Belt market counterparts like Dallas, Houston, and Atlanta. Furthermore, the first projects that were delivered in the late 1990s weren't the out-of-the-ballpark home runs evident elsewhere. Developers learned the hard way that the pedestrian-friendly, live-work-play environment that holds so much appeal in other cities faces some challenges in attracting renters when daytime temperatures top 100 degrees during much of the year. After Bank One moved about 1,000 workers downtown in late 2004, the urban core product that exists here did fill up, and occupancy was stable near 95 percent throughout 2005. These projects capitalized on this newfound success with some of the strongest rent growth anywhere in the metro, as same-store rents surged by 12 percent.
Phoenix's downtown could be transformed dramatically by a proposed new campus for Arizona State University that could accommodate 15,000 students and provide up to 7,700 jobs. The vision for the campus, the university's fourth metro Phoenix location, calls for an urban mixed-use development that features ground-level dining and retail facilities, academic and residential buildings, and open parks. If development proceeds, the project's housing component will be contracted out to the private sector.
With the emergence of desirable living environments in the urban core and the western suburbs, metropolitan Phoenix's apartment investment opportunities no longer are limited to the traditionally favored east side. And if the metro's market fundamentals live up to expectations, investment returns should grow more stable and sustainable in this desert oasis.
Banner Year
Freddie, Fannie report record multifamily deal volume.
Everybody thought that multifamily transaction volume couldn't get any more torrid than 2004. Then came 2005, proving itself a record year for the industry and finance giants Freddie Mac and Fannie Mae.
Last year, Freddie tallied $26.2 billion in new multifamily business transactions, its biggest year ever. The main driver? Freddie's $10 billion flow program, which included about $6 billion of fixed-to-float loans, where borrowers agree to a yield maintenance provision that applies to the full loan term for a reduced interest rate, and more than $1.1 billion in affordable products.
It also provided more than $2.2 billion in capped ARM flow transactions, which allows for a floating-rate for the full term on the loan with an established maximum interest rate, and $1 billion in structured commercial mortgage-backed securities programs, or CMBS. "A big part of CMBS growth is coming from the capital that's flowing around the market," says Mike May, senior vice president of Freddie Mac's multifamily sourcing division. "Wall Street is delivering what the investor base wants. That creates price pressure in the market."
Fannie Mae also had a big year, investing $25.6 billion in 2005 for its second-biggest year ever. Its multifamily affordable housing group led the charge, having invested $3 billion last year. More than 90 percent of the rental units financed by Fannie last year were affordable for families at or below the median income for their communities.
Like the rest of the market, the affordable markets were driven by a high investor appetite for multifamily. "In the [low-income housing tax credit], there is a lot of competition and increased pricing of the credits," says Richard Lawch, Fannie's senior vice president of multifamily lending and investment. "The equity in the LIHTC is competitive because there's a lot of capital in the market."
–Les Shaver
Holiday Gift
Occupancies and effective rents register improvement in late 2005.
Christmas came right on time in 2005 for apartment owners and managers. According to Marcus & Millichap, a multifamily brokerage and research firm, occupancy rose to 94.3 percent in 2005's fourth quarter, pushing revenue up 1 percent compared to the previous quarter.
Occupancy gains have been the leading source of growth in the revenue index. In fact, 2005 saw the largest one-year occupancy gain in more than 25 years with a 110 basis point increase.
Effective rents also inched upwards in 2005's fourth quarter, bringing the year's effective rent growth to 3.3 percent. And as occupancy approaches 95 percent, apartment firms can expect effective rents to grow more than 5 percent in 2006.
On the completion side, apartment completions remain low. In addition, approximately 122,000 units were removed from the inventory last year due to conversion to condos or redevelopment.
–Marcus and Millichap
